Value Chain Analysis

Value chain analysis is a strategic analytical and decision-support tool that

highlights the bases where businesses can create value for their customers. The
framework can also be applied to identify sources of competitive advantage for
businesses. Value chain is a set of consequent activities that businesses perform
in order to achieve their primary objective of profit maximization.

Theory of Value Chain Analysis

The concept value chain analysis was introduced by Michael Porter in
1985[1] and its significance and relevance to strategic management and
marketing has not diminished during 30 years of its existence.
The framework divides activities that generate value into two categories
primary activities and support activities. Primary activities comprise a set of
activities that contribute to the creation of value in a direct manner. Support
activities consist of functions and tasks that are intended to support primary
activities.
It is important to clarify that the relevance of value chain analysis is not limited to
manufacturing businesses and the framework can be applied towards service
firms as well.

Primary Activities
Inbound logistics involve receiving and storing raw materials and their usage
in manufacturing as the necessity arises.
Operations relate to the processes of transforming raw materials into finished
goods. For businesses operating in services sector operations relate to the process
of providing the service.

Outbound logistics is associated with warehousing and distribution of finished

products.
Marketing and sales refer to the choice and implementation of marketing
strategy to communicate the marketing message to the target customer segment
and generation of sales.
Service relates to support provided to customers after the sale.

Support Activities
Infrastructure of a company comprises its organizational structure, its
departments and committees, organizational culture etc.
Human Resource Management involve a wide range of activities related to
employee recruitment and selection, training and development, appraisals,
motivation and compensation.
Technology development involves the use of technology to increase the
effectiveness of primary activities in terms of value creation.
Procurement relates to the purchasing practices of raw materials, tools and
equipment.

Businesses need to engage in value creation via their primary and support
activities in order to survive in the marketplace. Value can be created in one of
the following two ways.
a) Cost advantage: Businesses can reduce the costs of activities wherever
possible and use the cost benefit to reduce the price of their final products or
services
OR

b) Differentiation: businesses can focus on activities closely associated with

their competitive advantage. Investing in activities adapted as sources of
competitive advantage allows the business to increase the quality of their
products and services and sell them for higher prices.

Advantages and Disadvantages of

Value Chain Analysis
Application of value chain analysis offers the following advantages:
1. Value chain analysis can play an instrumental role in terms of detecting
organizational, tactical and strategic issues related to the business.
2. The tool assists businesses to appreciate potential sources of competitive
advantage.
3. The strategic framework can be applied to any type of business regardless of
the industry and the size of the business.

As it is the case with any other theoretical framework or model, the concept of
value chain is not free from limitations. These can be summarized into the
following points:
1. The framework assumes that it is possible to achieve a clear separation of
company operations into different primary and support activities. This may not
be the case in real life taking into account increasing level of complexity of
business operations.
2. Application of the tool in practice can be overly time-consuming process, since
it requires a comprehensive analysis of all business operations.

3. It may be difficult to find all the required information in order to conduct value
chain analysis in an appropriate manner.
Porter's five forces analysis is a framework that attempts to analyze the level of competition within
an industry andbusiness strategy development. It draws upon industrial organization (IO)
economics to derive five forces that determine the competitive intensity and therefore attractiveness
of an Industry. Attractiveness in this context refers to the overall industry profitability. An
"unattractive" industry is one in which the combination of these five forces acts to drive down overall
profitability. A very unattractive industry would be one approaching "pure competition", in which
available profits for all firms are driven to normal profit.

Five forces

Threat of new entrants[edit]

Profitable markets that yield high returns will attract new firms. This results in many new entrants,
which eventually will decrease profitability for all firms in the industry. Unless the entry of new firms
can be blocked by incumbents (which in business refers to the largest company in a certain industry,
for instance, in telecommunications, the traditional phone company, typically called the "incumbent
operator"), the abnormal profit rate will trend towards zero (perfect competition).
The following factors can have an effect on how much of a threat new entrants may pose:

The existence of barriers to entry (patents, rights, etc.). The most attractive segment is one
in which entry barriers are high and exit barriers are low. Few new firms can enter and nonperforming firms can exit easily.

Government policy

Capital requirements

Absolute cost

Cost disadvantages independent of size

Economies of scale

Economies of product differences

Product differentiation

Brand equity

Switching costs or sunk costs

Expected retaliation

Access to distribution

Customer loyalty to established brands

Industry profitability (the more profitable the industry the more attractive it will be to new
competitors)

Threat of substitute products or services[edit]

The existence of products outside of the realm of the common product boundaries increases
the propensity of customers to switch to alternatives. For example, tap water might be considered a
substitute for Coke, whereas Pepsi is a competitor's similar product. Increased marketing for drinking
tap water might "shrink the pie" for both Coke and Pepsi, whereas increased Pepsi advertising would
likely "grow the pie" (increase consumption of all soft drinks), albeit while giving Pepsi a larger slice
at Coke's expense. Another example is the substitute of a landline phone with a cellular phone.
Potential factors:

Buyer propensity to substitute

Relative price performance of substitute

Buyer switching costs

Perceived level of product differentiation

Number of substitute products available in the market

Ease of substitution

Substandard product

Quality depreciation

Availability of close substitute

Bargaining power of customers (buyers)[edit]

The bargaining power of customers is also described as the market of outputs: the ability of
customers to put the firm under pressure, which also affects the customer's sensitivity to price
changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program.
The buyer power is high if the buyer has many alternatives. The buyer power is low if they act
independently e.g. If a large number of customers will act with each other and ask to make prices
low the company will have no other choice because of large number of customers pressure.
Potential factors:

Buyer concentration to firm concentration ratio

Degree of dependency upon existing channels of distribution

Bargaining leverage, particularly in industries with high fixed costs

Buyer switching costs relative to firm switching costs

Buyer information availability

Force down prices

Availability of existing substitute products

Buyer price sensitivity

Differential advantage (uniqueness) of industry products

RFM (customer value) Analysis

The total amount of trading

Bargaining power of suppliers[edit]

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw
materials, components, labor, and services (such as expertise) to the firm can be a source of power
over the firm when there are few substitutes. If you are making biscuits and there is only one person
who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with
the firm or charge excessively high prices for unique resources.

Potential factors are:

Supplier switching costs relative to firm switching costs

Degree of differentiation of inputs

Impact of inputs on cost or differentiation

Presence of substitute inputs

Strength of distribution channel

Supplier concentration to firm concentration ratio

Employee solidarity (e.g. labor unions)

Supplier competition: the ability to forward vertically integrate and cut out the buyer.

Intensity of competitive rivalry[edit]

For most industries the intensity of competitive rivalry is the major determinant of the
competitiveness of the industry.
Potential factors:

Sustainable competitive advantage through innovation

Competition between online and offline companies

Level of advertising expense

Powerful competitive strategy

Firm concentration ratio

Degree of transparency